Bridgewater Bancshares, Inc. (NASDAQ:BWB) Q4 2022 Earnings Call Transcript

Bridgewater Bancshares, Inc. (NASDAQ:BWB) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Good morning, and welcome to the Bridgewater Bancshares 2022 Fourth Quarter Earnings Call. My name is Joe and I will be your conference operator today. All participants have been placed in a listen only mode during the duration of the call. After Bridgewater’s opening remarks, there will be a question-and-answer session . Please note that today’s call is being recorded. Now at this time, I would like to introduce Justin Horstman, Director of Investor Relations to begin this conference call. Please go ahead.

Justin Horstman: Thank you, Joe and good morning everyone. Joining me on today’s call will be Jerry Baack, Chairman, President and Chief Executive Officer; Joe Chybowski, Chief Financial Officer; Jeff Shellberg, Chief Credit Officer; and Nick Place, Chief Lending Officer. In just a few moments, we’ll provide an overview of our 2022 fourth quarter financial results. We will be referencing a slide presentation that is available on the investor relations section of Bridgewater’s Web site investors.bridgewaterbankmn.com. Following our opening remarks, we will open it up for questions. During today’s presentation, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company.

We caution that such statements are predictions and that actual results may differ materially. Please see the forward looking statement disclosure in our 2022 fourth quarter earnings release. For more information about risks and uncertainties which may affect us. The information we will provide today is as of December 31, 2022 and we undertake no duty to update the information. We may also disclose non-GAAP financial measures during the call. We believe certain non-GAAP financial measures in addition to the related GAAP measures provide meaningful information to investors to help them understand the company’s operating performance and trends and to facilitate comparisons with the performance of our peers. We caution that these disclosures should not be viewed as a substitute for operating results determined in accordance with GAAP.

Please see our 2022 fourth quarter earnings release for reconciliations of non-GAAP financial or non-GAAP disclosures to the comparable GAAP measures. I would now like to turn the call over to Bridgewater Chairman, President and CEO, Jerry Baack.

Jerry Baack: Thank you, Justin and thank you, everyone for joining us today for our first ever earnings call. We’re excited to begin hosting quarterly earnings calls as we think it will be a good way for us to provide more insight into our financial results and share more about what we’re seeing across the business. Started on Slide 3, we provide an overview of our strong full year 2022 earnings. Since our IPO in 2018, our results have consistently been highlighted by robust balance sheet growth, a highly efficient business model and superb asset quality. This was the case again in 2022 as we saw loan growth of 27% and an efficiency ratio of 41.5%, and non performing assets to total assets of just 1 basis point. All of which are among the best in the industry.

As a result, we had another record earnings and revenue year in 2022. Our sustained growth throughout the year was due to the hard work of our team members as we continue to build and develop client relationships, as well as deepening our brand presence and the ongoing market disruption in the Twin Cities. Finally, one of the most important metrics to us is tangible book value as it is a good measure of shareholder value we are creating. We’re able to grow tangible book value by 6.5% in 2022 despite the market value depreciation of the securities portfolios related to rising interest rates, which put significant pressure on tangible book value across the industry. Turning to Slide 4. We reported 2022, fourth quarter earnings per share of $0.45, which was driven by a continuation of our strong growth, efficiency and asset quality trends, as well as emerging funding pressures which impacted the net interest margin as interest rates continued to rise.

Loan growth remains strong with balances increasing 22% annualized during the quarter as we continue to get in front of high quality deals. Given the level of loan growth we’ve seen — that we’ve been able to generate during the year and where we are in the interest rate cycle, it’s not surprising to us that we’ve started to run up against funding pressures. While our teams continue to work to bring in core deposits, we have supplemented these with higher costs wholesale funding and borrowings to support our loan growth. Coupled with increased competition on interest rates to retain current deposit clients, we saw our net interest margin decline to 3.16% in the fourth quarter. Joe will provide more color on the margin and how we plan to manage the balance sheet as we head into 2023.

We continue to operate very efficiently during the quarter with an efficiency ratio of 44% even as we invest in our people and extremely low levels, and we saw no net charge offs in the fourth quarter. In fact, we finished 2022 with net recoveries for the year. As we head into a more uncertain environment in 2023, we’re taking steps to proactively assess our portfolio but at this point we’re really not seeing any early warning signs. With that, I will turn it over to Joe Chybowski.

Joe Chybowski: Thank you, Jerry. Turning to Slide 5, I’ll provide some more details on net interest income and the net interest margin compression we saw during the quarter. Over the last few years, we have seen strong growth trends in non-interest income driven by a relatively stable margin and robust loan growth. However, these trends have become more challenging to maintain based on where we are in the current cycle, as well as the further inversion of the yield curve. Last quarter, we indicated our expectation for flattening net interest income over the near term as we saw funding costs begin to rise. Coupled with our strong loan growth outlook, this implied a meaningful drop in the net interest margin and this is largely what we saw in the fourth quarter.

Our margin declined 37 basis points during the quarter, which was a bit more than we expected as robust loan growth resulted in the need for additional wholesale funding and borrowings. As a result, net interest income declined to $32.9 million. We were anticipating this margin reset for a couple of reasons. First is the recent growth in higher beta deposits and borrowings to support our robust loan growth. Second, we have a more sophisticated higher balance deposit client base that tends to be more sensitive to rising interest rates and has the wherewithal to move, especially given the unprecedented competition we have seen from the treasury market with yields north of 4%. Lastly, two thirds of our loan portfolio is made up of fixed rate loans, which means a slower pace of repricing initially.

This is evident on Slide 6 as you can see that funding costs have increased faster than loan yields so far. We expect loan portfolio yields to continue grinding higher for the foreseeable future, especially with yields on new originations today typically coming on at a 6.5% or higher rate. Many of which are being structured with strong prepayment penalties, which will help make these higher yield stickier for longer. In addition, we have over $400 million of fixed rate and adjustable rate loans scheduled to reprice over the next year and over $500 million of variable rate loans at or above their floors. On the funding side, we expect a steeper increase in funding costs to continue into the first quarter before beginning to stabilize. This all implies additional managers margin pressure from our fourth quarter margin of .

Looking ahead to the first quarter of ’23, we expect to see a similar pace of margin compression as we just saw in the fourth quarter with stabilization thereafter and the potential for margin expansion in the back half of the year as funding costs flatten and loan yields continue to expand. Obviously, this is all with the caveat that the interest rate outlook is uncertain and can always change. Our expectations assume fed funds peaks at 5% and remains there throughout 2023. Turning to Slide 7. We have demonstrated a long track record of strong revenue and profitability. This was impacted in the fourth quarter by the margin compression we discussed given that the vast majority of our revenue is spread based. However, total revenue was still up 14% year-over-year.

On the feed side noninterest income was up 25% during the quarter as other noninterest income included elevated rate lock fees, which we don’t typically or we don’t expect to recur. Turning to Slide 8. We continue to operate with a high level of efficiency given our branch light model and CRE focused loan portfolio. Our efficiency ratio remained in the low 40% range at 43.8%. We typically look to grow expenses in line with asset growth, which we did in 2022 as core expense growth of 19% came in below our asset growth of 25%. Expense growth in the fourth quarter was a bit higher at 29% annualized rate, primarily due to derivative collateral fees, which we expect to remain elevated in 2023. With that, I’ll turn it over to Nick Place.

Nick Place: Thanks, Joe. Turning to Slide 9. We continued to generate robust loan growth as balances increased 22% annualized in the fourth quarter and nearly 27% year-over-year. Overall, we have seen a decline in demand in recent months as fewer deals are penciling out due to higher interest rates. However, our teams are continuing to get in front of good high quality clients with good yielding loans in our core business lines. For example, there are many large names in the Twin Cities that we’ve been trying to bring on board for years. We were able to bring some of these clients over during the quarter as other banks pulled back. This is similar to what we did in 2008 to 2010 to develop some of the long term client relationships we still have today.

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So despite the funding pressures our growth is creating in the near-term, we believe it puts us in a better position for the long term. We have certainly demonstrated a comfort level with growing the loan portfolio in excess of 20%, but we are also aware that our loan to deposit ratio is close to 105% as we enter to 2023 bear the top end of our comfort range. We are taking several actions to help manage the growth of the portfolio going forward, including selling participations on new loans, being more selective on pricing and credit and requiring increased compensating deposit balances on new and renewed loans. We do expect a much slower pace of loan growth in 2023 as we look for better alignment with core deposit growth. Turning to Slide 10.

Given the reduced loan demand in the market, we continue to see a slower pace for originations and advances, which totaled $313 million in the fourth quarter, down 13% year-over-year. However, this has been more than offset by the decline in payoffs and pay downs, which is contributing to the continuation of our robust loan growth. Pay offs and pay downs declined 37% from a year ago as many borrowers have interest rates below current market rates making refinancing less attractive. As I mentioned, we have also been selling participations on new originations to help manage our growth. Over the past two quarters, we have sold 116 million of participations for 17% of our total originations and advances. Our loan participation portfolio balance is now over $425 million and over $580 million including unfunded commitments.

In addition to helping manage our growth, this servicing provides an added revenue benefit as well. On Slide 11, you can see we had strong fourth quarter loan growth across the various loan types led by multifamily, which continues to be a key growth driver given our expertise in the Twin Cities market and the low risk characteristics of the portfolio. We also saw good growth in the construction and development portfolio, which we expect to continue in 2023 given the upcoming construction draws on existing loans. As these projects complete their construction phase, some of the balances will migrate into other loan portfolios similar to what we saw in prior quarters. In addition to continued growth in the C&I portfolio, we are taking steps to expand our C&I function to help drive incremental growth and diversification of our loan portfolio while also creating new deposit growth channels over time.

This is a long term initiative we are building out in 2023 that will take time to implement but we expect to see the benefit in future years. Turning to deposits on Slide 12. Growth has remained strong as balances increased 13% annualized during the fourth quarter and 16% year-over-year. As we’ve mentioned, generating sufficient core deposit growth to keep up with our loan growth became more challenging later in 2022. In addition, new deposit relationships don’t always come in a linear fashion given the larger nature and sophistication of our commercial deposits, which have longer and less precise onboarding than our loan pipeline. As a result, we brought in more higher beta brokered deposits and borrowings during the fourth quarter than we have in the past.

Over the course of 2023, our focus will be on funding more of our loan growth with lower beta core deposits. It is worth noting that we have — the cumulative beta on our core interest bearing deposits has been well controlled at 31% cycle to date. Increased funding from core deposits should help our overall spreads even as betas are likely to continue trending higher. I’ll now turn it over to Jeff Shellberg.

Jeff Shellberg: Thanks, Nick. Turning to Slide 13, our asset quality continues to be superb. Non-performing assets have been steadily declining from already low levels and totaled just 0.01% of total assets at year end. In addition, we had no net charge offs for the second consecutive year. In fact, we have had cumulative net charge offs of just $381,000 over the last five years. This is largely due to our measured risk selection, consistent underwriting standards, active credit oversight and experienced lending and credit fees. While we have seen an extended period without credit issues, we do expect normalization at some point given the higher interest rate environment and potential recession on the horizon. Therefore, we’re taking proactive steps to address our future credit concerns.

For example, we’re evaluating loan repricing risk by assessing our client’s ability to meet loan covenants in the current interest rate environment. It’s worth noting that our fixed rate loan portfolio actually helps from a credit standpoint as it reduces some of the repricing risk. In addition, we will be adopting CECL in the first quarter and we do not expect the material day one impact given our low historical losses. In terms of classified assets, we saw a decrease of $2.7 million in the fourth quarter. The bottom of Slide 14 provide some more detail on our classified assets, which made up less than 1% of total loans and just over 5% of total capital. The majority of the classified assets are C&I loans. In the fourth quarter, we saw a $9.5 million increase in watchlist balances, primarily due to two relationships we moved to watch.

These relationships included the multifamily and C&I relationship and reflect our ongoing monitoring of the loan portfolio. Overall, we feel good about the risk profile of the portfolio and feel it is well positioned as we head into 2023. I’ll now turn it back over to Joe.

Joe Chybowski: Thanks, Jeff. Slide 15 highlights our strong capital and liquidity positions. We remain comfortable with our current capital levels at CET1 ratios, finished the year at and tangible common equity at . We did see our capital ratios trend lower in 2022 primarily due to robust loan growth and $10.8 million of common stock we repurchased throughout the year. Although we did not purchase any stock during the fourth quarter. We will be looking to build our tangible common equity and CET1 ratios backup throughout 2023 as we slow the pace of loan growth and continue to retain earnings. From a capital priority standpoint, organic growth remains our primary focus. Beyond that we continue to review and evaluate potential M&A opportunities.

We also have a new $25 million stock repurchase program that was approved by the board in 2022. However, it is unlikely we will repurchase shares in the near term as we look to build capital levels from here, but will remain opportunistic based on market conditions. We also remain comfortable with our liquidity position as we maintained $1.4 billion of on and off balance sheet liquidity at year end with our investment portfolio being completely unencumbered. Turning to Slide 16. I’ll summarize our thoughts on our near term expectations as we head into 2023. We expect overall balance sheet growth to slow as we look to better align loan growth with core deposit growth and reduce our reliance on higher beta funding sources over the course of 2023.

Coupled with the loan pipeline that is about one third of what it was at its peak in mid 2022, we expect loan growth in the high single digit to low double digit range for 2023. In general, the more core deposit growth we’re able to bring in the more loan growth we will be comfortable with. There are a couple of factors to keep in mind here. First, the level of payoffs and pay downs is difficult to predict and can affect our net growth. Second, we already have built in fundings coming in throughout 2023 on previously originated construction loans totaling approximately 5% of our loan portfolio today. Overall, we plan to maintain a loan to deposit ratio in the 95% to 105% range. As I mentioned earlier, we expect margin compression in the first quarter to be similar to what we just saw in the fourth quarter.

However, we expect the margin to then stabilize near first quarter 2023 levels with the potential for expansion in the back half of the year as loan repricing catches up to the funding side. Once the margin stabilizes, growth in net interest income will again be tied to the pace of loan growth, similar to what we have seen over the past several years. We expect our efficiency ratio to move slightly higher into the mid 40% range, which is still very strong as margin pressure impacts revenue. We also expect noninterest expense growth to slow a bit and align with our slower pace of asset growth. And as I mentioned from a capital standpoint, we will look to build our tangible common equity and CET1 ratios throughout 2023. I’ll now turn it back over to Jerry.

Jerry Baack: Thanks, Joe. Before we open up for questions, I want to take a minute to look back at the 2022 strategic priorities were identified and a look ahead to our priorities in 2023. On Slide 17, our first priority in 2022 was to continue our balance sheet growth trajectory, which we did as loan growth was very strong. We also invested in our business scalability, including the launch of Encino commercial origination system in March. This is in addition to other partnerships we’ve established such as ServiceNow, and Salesforce. As I’ve mentioned, we continue to operate one of the most efficient business models in the industry with expense growth coming in lower than asset growth. And last week, we recruited, developed and retained top talent.

While we didn’t add as many people as we were expecting due to the challenging hiring environment, our employee base still increased 12% during the year, including key hires across all areas of the bank. Finishing up on Slide 18, our strategic priorities for 2023 are based on positioning the bank for long term success. First, we want to manage high quality balance sheet growth by better aligning our loan growth with core deposit growth over the course of 2023. Second, we want to maintain our strong efficiency while continuing to invest in the business. Given the slower pace of balance sheet growth, this means pulling back on some expenses, which we plan to do by looking at areas of discretionary spend we can eliminate, while also continuing to leverage and embrace technology investments we have made in recent years.

Third, we want to proactively assess asset quality and repricing risk as we expect credit to normalize at some point. Jeff shared his thoughts on this earlier. Last week, we want to implement initiatives that prepare us for longer term success. This includes a C&I build out initiative Nick mentioned earlier, as well as preparing to be opportunistic as M&A opportunities become available. Overall, while the environment remains challenging as we begin 2023, we remain optimistic that the actions we’re taking now will allow us to continue to be our usual strong growth and high efficiency bank over the long term. With that, we’re going to open this up for questions.

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Q&A Session

Operator: And our first question here will come from the line of Brendan Nosal with Piper Sandler.

Brendan Nosal: To start off here just on the margin question kind of after the first quarter. It really feels like a slowdown in deposit pricing increases is really the key to getting that stabilization if not inflection later in the year. So just talking about your confidence that you can actually realize that that slowdown and stability and funding pressures rather than just a continuous grind higher kind of throughout the year?

Joe Chybowski: I think, for us, I mean, if you look at the growth that — in the third and fourth quarter, with the pace of loan growth and having to kind of fill the gap with higher cost wholesale funding or broker deposits, I mean, when we, we highlighted the core deposit betas that we’ve experienced and we feel confident our ability to grow core deposits throughout 2023. And I think, given those beta levels, those are obviously meaningfully lower than where it is to borrow overnight or in the wholesale markets. So that’s really the, from your funding cost question, I think our ability to continue to grow core deposits which, we have line of sight to real opportunities and feel good about them throughout 2023. We feel like, those coming in at lower betas than really the wholesale markets should certainly — that’s definitely margin accretive from there.

And then I think on the flip side, on the asset side as we talked about, I mean, the more time passes, the more time for the loan book to reprice in this higher rate environment. And I think also, the other piece to talk about is really the slowdown in pay downs and pay offs that we experienced in 2022. I mean, obviously, there’s a component to the margin that’s loan fee based. And so you saw on the last quarter that was in half compared to what it was in the third quarter and certainly quarters historically. So it feels like if loan payoffs do pick up and you do see an acceleration of that loan fee income, obviously, that’s margin positive as well.

Brendan Nosal: Maybe one more from me, just kind of given the intention of slowdown in loan growth. Just kind of curious how you keep your lending staff motivated in light of that after a very long track record of years of much higher growth?

Jerry Baack: We’re actually had — we had a meeting with their whole learning stuff last night actually talked through that. I mean, obviously, we’re incentivizing them and to eagerly go out and get deposits versus loans which, it is a change in their thought process and how they go out and sell. But our staff has been really good at representing the bank out there and kind of pivoting when they need to. And I’ll probably let Nick maybe talk a little bit more about it since he manages all of them.

Nick Place: The only thing I’d add to that is — and we touched on it in our presentation, I think, we will continue to find good new loan opportunities. I think we’re just encouraging our staff to be diligent about focusing on those types of opportunities that will help bring really good long term growth for the organization through acquiring core, well known, long history, well healed clients that we can do good business with in the long term. So we had some of those wins in the fourth quarter. We’ve got some additional wins that we’re working on now. And then we’re just really focusing on the deposit aspect, as Jerry mentioned, which allows us to continue to fund the transactions of our long term historical clients, which is really where we’re trying to put our time and energy today. So I echo Jerry’s comments that our staff feels good about the game plan going forward and how we’re going to try to continue to manage the balance sheet through 2023.

Operator: Our next question will come from Jeff Rulis with D.A. Davidson.